Monday, March 26, 2012

Last week, I wrote that the character of the stock market had changed. The market had gone from a central bank liquidity driven rally, which favors hard assets and asset inflation plays, to a focus on the American consumer as a source of growth (see This bull depends on the US consumer).

To review, leadership had gone to Consumer Discretionary stocks, which was in a relative uptrend against the broad market:

...and Financials, which had broken its relative downtrend line and has now staged a relative breakout through resistance:

Europe mirrors the US
I reviewed the chart patterns of the European sectors on the weekend and (to my surprise) found a similar pattern. European Financials had broken out of a relative downtrend, but they weren't as strong as American Financials as they have not yet staged a relative breakout, but appear to be undergoing a sideways relative consolidation:

European consumer stocks are broken down as Consumer Goods and Consumer Services, which is not quite the same categorization that we find in the United States. Nevertheless, I was surprised to see that the European Consumer Goods sector has been in a long relative uptrend against the market and had staged a relative breakout and pullback after spending several months undergoing a sideways consolidation period:

The European Consumer Services sector was not as strong, but had nevertheless provided leadership in the latest rally.

Market bullish on US and Europe consumer, but worried about China
When I look around the world and listen to the market, the stock markets are telling me that first stage booster of central bank liquidity has dropped and and it's up to the second stage rocket, namely the American and European consumer, is on course to lift us past escape velocity. There is one drag to our rocket, however, and that's the prospect of a slowdown in China, as the weakness in commodity prices and commodity sensitive currencies are signaling those concerns.

Expect a rally, but define your risk tolerance
A bullish bet is therefore a bet on the health of the American and European consumer - and that is indeed a fragile foundation for a rally. Nevertheless, unless I am convinced otherwise the stock market remains in an uptrend. The chart below shows the weekly NYSE Summation Index, which is a breadth indicator, which I have overlaid a slow stochastic, an overbought/oversold indicator. If past history is any guide, stocks are tactically oversold and likely to rally in the next couple of weeks.

If you believe that we are in an uptrend, then the current period is likely to resemble the circled December 2010 correction and consolidation period in the middle of the QE2 rally. If you believe that the market is likely to correct further, another analog (circled) might correspond to the weakness seen in June 2010.

In both cases, the oversold readings of the stochastic point to a tactical rally in stocks for the next couple of weeks. In all cases, it would be wise to stay long, but carefully define your risk tolerance with the appropriate stop loss orders. In the meantime, watch the news flow and in particular closely watch how the market reacts to news coming out of China.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

2 comments:

Great analysis as usual. I agree that it is all about the US consumer. A lot of people have said that the recent jump in Treasury yields is a sign of an improving economy. But if interest rates go up, won't this slow down the US consumer who will be inclined to pass on refinancing their mortgages and spend less? Also, won't the higher oil prices also slow down the US consumer?

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Welcome to my blog Humble Student of the Markets. These are my observations and musings about the markets (mostly equities), hedge funds and investments in general.My experience has been a quantitative equity manager in US, Canada, EAFE and Emerging Markets and commentator on hedge funds and their returns patterns.

DISCLAIMERThis is not investment advice! I know nothing about you, your risk preferences, your portfolio or your investment horizon. I have no idea whether any of my opinions expressed are suitable for you.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. I may hold or control long or short positions in the securities or instruments mentioned.